2/08/2012 @ 6:00PM

Shale Game

At the start of last year Marius Kloppers had $10 billion burning a hole in his pocket. Rebuffed in attempts to acquire mining rival
Rio Tinto
as well as
Potash Corp. of Saskatchewan
, the chief executive of
BHP Billiton
needed a big deal to deploy the $24 billion in profits the company had piled up last year feeding Chinas insatiable appetite for natural resources.

He found it in Arkansas, shelling out $4.75 billion to ­acquire gas giant
Chesapeake Energy
s acreage in the ­Fayetteville Shale. Then in July he bet again, paying $15 billiona 65% premium to market valuefor
Petrohawk Energy
and its accumulation of prime shale fields in Louisiana and Texas. Though BHP had zero experience drilling for shale gas, the deals suddenly made the worlds largest and richest mining company, headquartered in Melbourne, Australia, one of the 15 largest natural gas producers in ­America. Even for Kloppers, whos a 19-year veteran of
BHP Billiton
and known for his steeliness in building one of the most powerful commodities companies of the past half-century, it all looks riskymaybe too risky.

Evy Hambro, manager of a $30 billion mining fund at
BlackRock
, wondered aloud last fall what BHP had gotten his clients into. We are waiting to be educated by BHP on these transactions, Hambro said at a Melbourne conference in ­October. When you start putting something on your stall that youve never told investors about, people are naturally a bit ­reserved. So when you are suddenly exposed to shale gas, you want to know why.

For one thing, BHP Billiton Petroleum, the oil-and-gas ­subsidiary, has focused mostly on deepwater projects; it hadnt fracked a single shale well until it took over the operations of Chesapeake. Meanwhile, the U.S. nat-gas glut shows no signs of abating. The price of domestic gas already appeared to be at a nadir at $4.25 per thousand cubic feet (mcf) when the Petrohawk deal was cut. Yet in the intervening months prices fell to $2.30 per mcf in early February, a depth not seen since 2002 and so low that drillers are losing money on marginal shale fields. Shares of big gas drillers have fallen, and in January gas giants Chesapeake Energy and
ConocoPhillips
both announced they would curtail gas development to pare losses.

As if that werent enough for shareholders to worry about, the $20 billion shale outlay is just an ante. Michael Yeager, the Houston-based chief executive of BHP Billiton Petroleum, says it will take ten years and at least $50 billion in capital investment to develop these assets. By comparison,
Rio Tinto
and Potash Corp. are already mature companies that throw off loads of cash.

Kloppers shrugs off the Cassandras. Shale gas is like coal mining, he says. Like coal the formation is extensive, and you can programmatically and at lowest cost move through the basin and extract the gas. Besides, it has held on to most of Petrohawks 800 employees and many key engineers.

Yeager admits that for the average well in the Fayetteville and Haynesville shales BHP needs gas prices of $3 and $4 per mcf just to break even. Yet, he says, Petrohawk had laid claim to the thickest, juiciest acres in those plays, where the ­economics are slightly better. Whats more, in the oil-rich Eagle Ford and Permian Basin acreage, BHP can give away the gas and still make good profits on the oil.

The executives believe that in time demand will follow supply. Shale is a game changer; its real, its abundant, its economic, says Yeager, a former Marine who spent 26 years at Exxon. On a global basis it is cheap molecules.

Eventually the U.S. will connect cars to natural gas, says Kloppers. And if thats not enough to raise the gas price, there are exports. A handful of liquefied natural gas export terminals are already in the works on the U.S. Gulf Coast. Considering that LNG fetches $15 per mcf in Asia and $10 per mcf in Europe, putting a price marker down for export gas is an important thing, says Kloppers. Hes convinced that natural gas, like oil, will someday fetch pretty much the same price all over the world. We are confident, based on all the other products weve got, that the arbitrage will continue, says Kloppers.

REUTERS/Toby Melville

He should know. Kloppers, 49, joined Billiton back in 1993. He leapt up the ranks, and at the time of Billitons merger with BHP in 2001 the wunderkind was appointed chief ­marketing officerresponsible for matching his supply with customer demand on a myriad of minerals. In 2005 he ­spearheaded BHP Billitons $7 billion acquisition of Australias Western Mining Co. (which owned BHPs new Olym­pic Dam megaproject).

When he was appointed CEO of BHP Billiton in 2007 the global mining business had never been better, as booming demand in China, where BHP sells 30% of its products, fattened bottom lines across the industry. Kloppers waited less than a month to launch an $80 billion takeover bid for rival Rio Tinto. It was a bold move that would have resulted in one of the worlds ten biggest companies. The deal made sense, too: As with BHP Billiton, Rios assets (Alcan acquisition aside) are high quality, long-lived and low cost. Yet the betrothal ultimately foundered in the wake of the global financial crisis.

Kloppers is not afraid of challenge or change. He grew up in Johannesburg, during the apartheid era. He was conscripted into South Africas war with Angola at age 18, went to the University of Pretoria, won a Fulbright scholarship, earned a doctorate at MIT and an M.B.A. at Insead, and worked as a consultant at McKinsey & Co. before joining Billiton. Married to his high school sweetheart, with three kids, including an adopted Zulu daughter, Kloppers is a family man. Hes also a sophisticate, a prodigious reader and a lover of avant-garde cinema who doesnt suffer fools.

Kloppers brushed off the Rio Tinto deal and in 2010 set his sights on the new target
Potash Corp. of Saskatchewan
. The hostile $30 billion bid was ultimately blocked by the Canadian government, which was unwilling to see control of possibly the worlds biggest potash reserves fall into foreign hands. No matter, Kloppers is taking the fight to Potash Corp. Having grabbed some ­undeveloped Canadian potash reserves, BHP is likely to invest $10 billion in its new Jansen mine.

Kloppers has fully rationalized the benefits of plunging BHP into shale gas. He speaks professorially of the sweep of civilizations and how BHP is set to supply their needs at every step of development. As economies grow they consume everything in infrastructure: steel, coking coal, manganese. As they continue to industrialize they need copper and nickel, aluminum, he says. As you hit $30,000 GDP per person economies consume more energy. They need more oil and gas.

The average Indian or Chinese is far from that, but give it a decade or two. Because BHP Billitons time horizon is closer to 30 years than 3 months, Yeager says, he has no problem swallowing several quarters of losses on certain shale fields. We want to become masterful at working shale. Not only here, but on a global basis. To that end he suspects the controversy over fracking will be short-lived. The industry is doing a great job of taking frack fluids and making them more benign and more safe, Yeager says, and BHP is dedicated to investigating greener fracking techniques.

BHP also has a good reputation for safety and was the first allowed to drill in the deepwater Gulf of Mexico after the
BP
oil spill. With BP, BHP is set to start the next phase of development on its 4-billion-barrel Mad Dog field. Yeager predicts BHPs oil and gas volumes will grow from 600,000 bpd now to 1 million bpd in 2015.

And if natural gas gets even cheaper? That would give BHP only more opportunities to pick off weaklings, it says. With their decades-long view, Kloppers and Yeager dont doubt in the least that world demand for gas, as a cleaner-burning fuel to supplant coal and oil, will grow. Shale is going to work around the world, and its going to be here for 50 years, says Yeager. Wouldnt it be irresponsible to not be in that?